What is a QM Loan? A Complete Guide

If you’ve been shopping around for a mortgage loan recently, you may have come across the term “QM loan.” But what exactly does it mean? QM stands for Qualified Mortgage, which is a special category of mortgage loans that meet certain requirements laid out in the Dodd-Frank Act passed after the 2008 financial crisis.

In this comprehensive guide we’ll explain everything you need to know about QM loans their benefits, and how to qualify for one.

What is a Qualified Mortgage (QM)?

A Qualified Mortgage (QM) is a type of home loan that meets specific standards outlined in lending regulations set by the Consumer Financial Protection Bureau (CFPB). QM loans have certain features that make them safer and less risky for consumers compared to non-QM loans

The Dodd-Frank Act established the criteria lenders must follow for a loan to qualify as a QM. The goal was to avoid a repeat of the loose lending practices that contributed to the subprime mortgage meltdown. QM loans are considered to have a lower risk of default because the borrower has been thoroughly vetted for their ability to repay.

Some of the key requirements for a QM loan include:

• Limits on debt-to-income ratio (DTI). Borrowers can’t have a DTI over 43%.
• Limits on points and fees. Total points and fees cannot exceed 3% of the loan amount.
• No risky features like interest-only or balloon payments.
• Verification of income, assets, and employment.
• Total loan term not longer than 30 years.

By meeting these requirements, QM loans offer more protection and transparency for borrowers.

The Benefits of a QM Loan

There are several advantages to getting a Qualified Mortgage loan as a borrower

1. Lower Interest Rates

Interest rates are often lower on QM loans because they are seen as less risky by lenders. Expect to see around a 0.5% lower rate compared to non-QM.

2. Better Loan Terms

QM guidelines prohibit certain high-risk features like balloon payments or prepayment penalties. This results in better and safer loan terms.

3. Stronger Borrower Protections

Lenders must fully verify your income and debts. This prevents people from getting loans they can’t afford.

4. Potentially Lower Mortgage Insurance

Better rates and terms on a QM loan may allow you to qualify for lower mortgage insurance premiums.

5. More Options If You Default

With a QM loan, you may have more legal recourse options if you default or the lender committed fraud.

6. Easier to Resell Your Loan

QM loans meet secondary market guidelines for buying mortgages. This provides more liquidity options.

Overall, going with a QM loan means a safer, more transparent loan process that reduces your risk as the borrower.

QM Loan Requirements

To be categorized as a Qualified Mortgage, a loan must meet the following criteria:

• Limits on Points and Fees – Total points and fees paid to the lender cannot exceed 3% of the total loan amount. On loans below $100,000, the limit is higher at 5%.

• No Risky Loan Features – Qualified Mortgages cannot have features like interest-only payments, negative amortization, balloon payments, or terms exceeding 30 years.

• Income Verification – Lenders must make a good faith effort to verify your employment status, income, assets, and other financial information.

• Debt-to-Income Limits – Your total monthly debt payments divided by your monthly gross income cannot exceed 43%. This includes the new mortgage payment.

• Qualified Interest Rate – The Annual Percentage Rate (APR) must be below a certain threshold pegged to average prime offer rates. This helps avoid excessively pricy loans.

• Underwriting Standards – Lenders need to carefully evaluate your credit history, income, and assets to determine you have the means to repay the loan.

• Mortgage Insurance – For loans with less than a 20% down payment, mortgage insurance is required from an acceptable provider.

Adhering to these requirements ensures borrowers aren’t taking on more debt than they can chew. It prevents the loose lending practices that were pervasive leading up to the housing crash.

Types of QM Loans

There are a few categories of Qualified Mortgages under CFPB guidelines:

Safe Harbor QM – This is the category that offers lenders the strongest legal protection. As long as the lender satisfies safe harbor standards, the borrower cannot claim in court they were unlawfully issued an unaffordable loan. Over 90% of QM loans are safe harbor.

Temporary QM – These were loans eligible for QM status under temporary provisions that have since expired. No new temporary QM loans can be originated.

Small Lender QM – This special QM category is for small lenders who issue less than $2 billion in mortgage loans annually and hold the loans in their own portfolios. Provides more flexibility.

Balloon QM – While balloon loans are normally not allowed under QM rules, an exception exists for small lenders in rural or underserved areas on loans held in portfolio.

The vast majority of QM loans will fall under the safe harbor category, which has the most rigorous standards. The other QM designations allow some flexibility for niche lenders and products.

How to Qualify for a QM Loan

To increase your chances of qualifying for a Qualified Mortgage loan, you’ll want to:

• Have a DTI ratio below 43% – This may require paying down existing debts.

• Avoid applying for loans within 90 days of a previous mortgage inquiry – Having too many loan applications can signal risk to lenders.

• Have income and assets that are easy to document – QM loans require full verification. Having strong proof of your financials will help.

• Make a down payment of at least 20% – This avoids private mortgage insurance requirements.

• Have a credit score over 680 – Lenders prefer credit scores above 720 for the best terms, but 680 is sometimes enough.

• Keep your total points and fees low – Try to minimize origination fees and discount points paid to the lender.

Shopping around among multiple lenders can help you find the most competitive QM loan for your financial situation. Be ready to document your income, assets, debts, and credit history.

QM vs Non-QM Loans

Non-QM or non-qualified mortgages are loans that don’t conform to CFPB’s criteria for QM status. These loans are seen as higher risk by lenders. Here are some key differences between the two types:

Interest Rates

QM loans often have 0.5% lower rates or even more compared to non-QM. The better terms reflect the lower risk to the lender.

Debt-to-Income Ratio

Non-QM loans may allow DTIs above 43%. This provides more options for borrowers, but comes with greater risk.

Documentation

Non-QM lenders can rely more on “stated income” without requiring documentation. This introduces more uncertainty around repayment ability.

Mortgage Insurance

Non-QM borrowers often have to pay higher mortgage insurance premiums due to the increased risk.

Regulatory Scrutiny

Non-QM lenders undergo less scrutiny and oversight. This shifts more risk onto the borrower.

For many borrowers, sticking with a QM loan is the smarter choice. But non-QM loans can offer more flexibility for unique cases like self-employed individuals with irregular income streams.

How Has the Housing Crisis Impacted QM Loans?

The subprime mortgage crisis of 2008 was sparked by reckless and predatory lending practices that issued too many loans to unqualified borrowers. Many of these mortgages had features like low teaser rates that spiked after a few years or allowed borrowers to defer interest payments.

When millions of these unaffordable loans went into default, it triggered a massive global financial meltdown. In response, Congress passed the Dodd-Frank Act in 2010 which established the Qualified Mortgage framework through the CFPB. The goal was to regulate mortgage lending so a similar crisis could be avoided.

As a result, QM loans have become the “gold standard” for most borrowers. Standards like verifying income and debt obligations help ensure consumers don’t end up with unaffordable loans. QM requirements have also discouraged the “liar loans” which relied on stated income without documentation.

However, some argue the regulations may have overcorrected by making lenders too conservative. Access to financing has tightened, especially for self-employed or gig workers with irregular income streams. But the QM framework remains widely credited with improving loan quality and financial stability.

The Future of QM Loans

In July 2020, the CFPB issued a new final QM rule which will come into effect July 1, 2022. It includes some key shifts: